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Indonesia has to make hard decisions on debt

Reading Time: 5 mins

In Brief

Indonesia’s next president will need significant funds to fulfil election promises. But both candidates Joko Widodo (Jokowi) and Prabowo Subianto have expressed caution about international borrowings.

So should Indonesia undertake the risks of borrowing from overseas?


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There is little consensus among Indonesian policymakers. The issue is a difficult and sensitive one, but what is the right course of action?

The case for government borrowing from overseas seems straightforward and persuasive — international capital markets are awash with liquidity and interest rates are at record lows. Also, Indonesia urgently needs funds to support new investments.

But how much should Indonesia borrow? The answer, in principle, is simple. Indonesia should keep borrowing — many billions of dollars if appropriate — so long as the rate of return on investment comfortably exceeds the cost of borrowing. If, for example, the Indonesian government can borrow in international capital markets at 6 per cent per year and investments at home have a return of 10 per cent per year, then surely Indonesia should keep borrowing.

Yet a ‘fear of borrowing’ is widespread across the political and policymaking elite in Indonesia.

The basic case for international borrowings rests on several assumptions. First, that the terms of borrowing (including the costs of borrowing and other conditions) are attractive. Second, that the funds can be used well, especially by investing in good projects at home. Third, that there are no problematic financial or other worrying risks in issuing debt.

Opponents of international borrowing in Indonesia say that none of these assumptions can be relied upon. They argue that the risk to Indonesia of raising large scale borrowings overseas is just too great.

For one thing, opponents of government borrowing point to the hidden costs of international borrowings. They point to the foreign exchange rate risks — arguing that while current costs of borrowing in US dollars are quite low, uncertainty and danger will arise if there is a significant depreciation of the Indonesian rupiah. The repayments in US dollars, they point out, will soon become quite onerous and perhaps they have a point.

The Indonesian rupiah has fallen significantly in the past few years — from around Rp9800 to the US dollar in mid-2011 to around Rp12,000 in recent months. So it seems true that there are considerable foreign exchange rate risks for Indonesia in borrowing from overseas.

Also, it isn’t always clear that the borrowed funds will be used to support good projects. There is a real risk that borrowed funds will be frittered away on disappointing white elephant projects. And there is, worryingly, a marked shortage of well-prepared projects in Indonesia. Some of the projects that have been mentioned in recent years have been slow to get off the mark. There has been talk, for example, of a very ambitious Sunda Strait Bridge project to provide road and rail links across from Java to Sumatra. This project would cost at least US$20 billion   and would be by far the largest single infrastructure project ever undertaken in Indonesia. As such, it would seem to be a suitable project to finance with official borrowings from overseas. Yet so far, despite much talk and repeated presidential promises, the plans for the bridge have gone nowhere.

Another worry about international borrowings is that financial complications will arise which could ultimately drag the government into negotiations about sour international debts. Senior Indonesian policymakers point to two bitter experiences that Indonesia has had with debt reschedulings.

One was in 1975 when a major debt crisis  occurred following the Pertamina crisis. The crisis broke out when it was revealed that the state-owned oil company Pertamina had gone on an undisclosed borrowing spree in international markets. The president director of Pertamina, Dr Ibnu Sutowo, had approved the borrowings of large amounts of short-term funds. The borrowings had been used to invest in longer-term projects, but Sutowo had not foreseen any repayment problems because he had assumed that Pertamina’s short-term debts could be continually refinanced in international markets.

But when, in the wake of the 1973–74 international ‘oil shock’, international capital markets suddenly dried up, Pertamina was faced with a cash-flow crisis. Eventually the problem was solved — but not without significant pain and damage to Indonesia’s standing in the international community.

It took years for Indonesia to build up credibility again in international financial markets.

More recently, the borrowing and debt problems that contributed to the 1997–98 Asian financial crisis in Indonesia imposed huge economic costs. In the midst of the Asian financial crisis Indonesia’s GDP fell by over 10 per cent in 1998 causing widespread unemployment and leading to a sharp increase in the national poverty rate. Recovery from the crisis was slow. It was not until almost a decade later that national income per person climbed once again to the pre-crisis level.

Although the benefits to be gained from a well-designed and successful international borrowing program are large for Indonesia, the risks are large as well. It is understandable that many policymakers are cautious. They are keen to see Indonesia invest in much-needed infrastructure but they have bitter memories from the past — it’s a hard choice.

Peter McCawley is a Visiting Fellow at the Crawford School of Public Policy, The Australian National University.

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